January 02, 2008

What Regulations Might Have Prevented the Housing Bubble?

Alan Greenspan is running around saying that there was nothing he or the FED could have done to prevent the catastrophic housing bubble we are experiencing today. Perhaps that is true if you are Alan Greenspan who is a true believer in Ayn Rand and the magical powers of the unfettered free market. Yet, it's not hard to see that if one is not quite so adverse to government regulations, some regulations just might have made a difference.

Here's what Countrywide Financial says about what would have been different if they had simply made a check on the borrower's income.

What's more, standards for making option ARMs were loosened starting in late 2004, when Wall Street firms began buying such loans in bulk to be converted into securities backed by the loan payments, Cecala said. Because lenders didn't have to keep the loans on their books, he said, they weren't too worried about the risk of losses.

As a result, loans of 90% or more of the home's value became the norm, up from a once-standard 80%. And many of the loans were made without verifying income or assets, even for borrowers who could easily have supplied that information -- an invitation for the borrower, loan officer or broker to fudge numbers, analysts say.

...Countrywide and other lenders tightened their lending standards last summer to ensure borrowers could afford loans after the interest rates adjusted upward.

Had those guidelines been in effect previously, Countrywide recently said, it would have rejected 89% of the option ARM loans it made in 2006, amounting to $64 billion, and $74 billion, or 83%, of those it made in 2005.

So, when you hear Alan Greenspan whining that he couldn't have done anything to forestall the housing bubble, you should remember that a small little change - simply checking to see if the borrower could afford to repay the loan - could have prevented 83% to 89% of the bad loans being made. Funny, huh?